ARC Resources Ltd

TSX:ARX

Earnings Call Transcript 2021-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the ARC Resources Ltd. Quarter 3 2021 Earnings Conference Call. [Operator Instructions] This call is being recorded on Friday, November 5, 2021. I would like to turn the conference over to Dale Lewko. Please go ahead.

[Dale Lewko]

Thank you, operator. Good morning, everyone, and thank you for joining us on our third quarter earnings conference call. Joining me on the call today are Terry Anderson, President and Chief Executive Officer; Kris Bibby, Senior Vice President and Chief Financial Officer; Lara Conrad, Senior Vice President, Development; and Armin Jahangiri, Senior Vice President, Capital Projects. Before I turn it over to our executive team to take you through our Q3 results and 2022 budget, I'll remind everyone that this conference call includes forward-looking statements and non-GAAP measures, with the associated risks outlined in the earnings release and our MD&A. All dollar amounts discussed today are in Canadian dollars, unless otherwise stated. The press release, financials, MD&A are also available on our website as well as SEDAR. Following our prepared remarks, we'll open the line to questions. With that, I'll turn it over to our President and CEO, Terry Anderson. Terry, please go ahead.

[Terry Michael Anderson, President, CEO & Director]

Thanks, Dale, and good morning, everyone. I'll keep my opening remarks brief and focus on what I believe is most relevant, which can be summarized in 5 key points: first, being the continual operational excellence of our business; second, the completion of the Seven Generations integration; third, our record production and free cash flow per share; fourth, the accelerated shareholder returns; and fifth, 2022 budget announcement. So over the past 12 to 24 months, we have observed the complexity of the energy environment and the importance of having a reliable and safe source of energy supply. ARC has established itself as a leading provider of that energy and is well positioned to retain that moving forward. Q3 was excellent across the board and really demonstrate the strength of our assets and the best-in-class people that run them. The team continues to build on our 25-year track record of safe and efficient operations. We delivered both record production and free cash flow per share eclipsing the previous mark set way back in 2006. Our operational momentum is very strong. Continuous improvement and our focus on operational excellence is truly part of our DNA, and we are seeing this materialize again in our results. Production of 354,000 BOE per day was above analyst expectations, and we continue to find tangible ways to improve efficiencies and reduce costs. Capital well costs have decreased by greater than 10% year-over-year, and we anticipate that further efficiencies will offset the inflationary pressures that our industry is facing. I think it's important to step back to realize our operating costs were $3.58 of BOE. And considering our production is 40% liquids, that is an exceptional number. Even though commodity prices are strong, we are still very focused on being a low-cost producer. In addition, we made excellent progress on the integration efforts. Today, we have realized 90% of the $160 million of synergies and are now on pace to exceed that total by year-end, primarily due to greater-than-anticipated capital synergies being realized. The anticipated the $25 million in capital synergies outlined in April will now double by year-end. It is true that large-scale integrations, like Southern Generations, are often difficult to execute successfully. However, the ARC team has worked tirelessly for 6 months, and the integration is now substantially complete and we are realizing significant value from this effort. We generated over $0.5 billion or $0.69 per share of free cash flow in the quarter, approximately 6% of our market cap, which was used to pay down debt and accelerate capital returns to our shareholders much faster than we anticipated. To this end, we have increased our quarterly dividend by 52% to $0.10 a share. The dividend increase reflects 2 things: first, our conviction in our business; and second, the greater profitability from fully capturing the synergies. We also put in place an NCIB as a complementary value creation tool. Since commencing in September, we have allocated over $200 million of free cash flow to repurchase $20 million in shares or approximately 3% of our stock. Even with the conservative commodity price assumptions, we perceive the intrinsic value of our business to be much greater than the share price. And therefore, we'll continue to utilize the NCIB to create value and per share growth. In addition to the quarter, we released our preliminary 2020 budget, which balances reinvestments with an accelerated return of capital to provide an attractive total return. Next year, the capital budget is $1.2 billion to $1.3 billion, of which $1.1 billion is to sustain production and the balance will be invested in 80 million cubic feet a day expansion at Sunrise, long lead items at Attachie and emissions reduction project at Dawson. Our budget is expected to deliver average production of 335,000 to 350,000 BOE per day. The Sunrise expansion is one of our highest return opportunities in our portfolio. Supply cost is well below $1 per Mcf. It's emissions intensity is near 0, and it's an excellent supply source for LNG given its proximity to inlet of Coastal GasLink. Related to that, we recently entered into a long-term supply gas agreement with an LNG Canada participant to deliver 150 million cubic feet a day of gas to the project, which equates to roughly 12% of our corporate natural gas volumes. We also continue to evaluate several measures to extract more profit along the value chain. Our resource depth, financial position, investment-grade credit rating and operating track record of delivering safely, on time and on budget makes us an excellent partner in these initiatives. Switching gears to Attachie, we plan to invest $75 million on long lead time items and we have plenty of flexibility to change the pace of spending based on the outcomes of negotiations between the Blueberry River First Nations and the BC government. The total cost of Phase 1 remains at approximately $600 million, inclusive of the $75 million earmarked for 2022. Once on production, we expect Attachie will generate $250 million of free cash flow at mid-cycle pricing or roughly $350 million at strip. The 2022 budget and dividend can be funded with cash flow down to $30 a barrel WTI. So with strip north of $70 today, there'll be meaningful return of capital component that Kris will talk about. Before turning it over to Kris, I want to stress that we can -- remain committed to building on our leading position as a low emissions producer with top-tier governance practices. We are one of the lowest emissions producers in North America, and we've set out to further reduce our Scope 1 and 2 emissions, both on an intensity and an absolute basis. We have committed to reducing our emissions intensity by 20% and absolute emissions by 70,000 tonnes of CO2 equivalent by 2025. Our targets are backed by a tangible plan to achieve them, and we continue to look for a viable and concrete path to becoming a net zero producer in the future. Finally, I want to again recognize our entire staff for their efforts in delivering a record quarter safely and efficiently despite operating in a challenging environment. With that, I'll turn it over to Kris to touch briefly on our financial highlights.

[Kristen J. Bibby, Senior VP & CFO]

Thanks, Terry, and good morning, everyone. I'll quickly touch on a few additional highlights related to our debt structure and how we think about capital allocation. But I do want to leave a decent amount of time for questions, so I'll be relatively brief, which is a rarity for me on these comments, and then we can get on to the questions. As Terry mentioned, good operational momentum and strong commodity prices resulted in a record quarter. Along with our low cost structure, our marketing efforts played an important role as we realized a [ gas print ] above $4.50 an Mcf or more than $1 above the AECO benchmark. Hedging losses offset some of these pricing tailwinds. The bulk of these positions will be rolling off in 2022. We will continue to manage risk through hedging, but our business is now better positioned to absorb volatility given our balance sheet strength, diversified commodity mix and our low-cost structure. We were able to reduce debt by an additional $158 million in the quarter and by 20% or $0.5 billion since we closed the Seven Generations transaction in April. As a result, we are now well positioned to return more of our profits to shareholders. We increased the quarterly dividend, as Terry mentioned, by 52% to a very sustainable level of $0.10 a share per quarter, and we've been actively purchasing our shares through the NCIB. As Terry also mentioned, we've retired approximately 3% of our shares since September. It's worth noting we optimize our debt structure to better align with our investment grade rating. We repaid our legacy ARC private note -- senior notes and amended and extended our $2 billion credit facility, which collectively lower our overall cost of debt to approximately 2.4%. Over time, we will continue to reduce debt, ideally targeting roughly $1 billion over the long term at our current size. However, the pace of debt reduction will slow in favor of allocating more prefund flow to shareholders. This is a great segue to capital allocation and how we intend to allocate our free cash flow in the future, which has been very topical amongst the investment community. Foundational to our strategy is a meaningful return of capital component as a part of the total return. And to return capital sustainably, you need to reinvest profitably in the business. So we will continue to do both. As we have stated before, once that's at the lower end of our target range, we will accelerate shareholder returns and we've now reached that inflection point. As we said in the press release, we intend to return 50% to 80% of our cash flow to shareholders -- free cash flow to shareholders, with the balance earmarked for further debt reduction. The needs of the business are fully met, capital program and the dividend are sustainable in a low commodity price environment, our financial position is very strong and we're very fortunate to have amassed a large drilling inventory in the highly profitable areas of the Montney. While we always look for opportunities to create value externally, the reality is what we looked at recently did not compete for capital against our internal investment opportunities or buying our own shares. In terms of the method to return capital, the dividend has always been the core mechanism and that has not changed. And obviously, we've just recently demonstrated that with our dividend increase this quarter. We will now supplement it with share repurchases during periods in which we think is a sound and profitable investment to do so. The base dividend will grow with our business and it's set to be sustainable, such that it can withstand extended periods at the bottom of price cycles, even below USD 40 WTI. Our payout is moderate under that scenario so that there's an opportunity for us to continue to grow the dividend and repurchase our shares, which we've obviously been doing so recently. If these changes, we'll continue to evaluate other capital return measures to ensure that we provide our shareholders with the most competitive return possible. And with that, I will turn it back to Terry for some closing remarks.

[Terry Michael Anderson, President, CEO & Director]

Thanks, Kris. To close, this quarter was an excellent demonstration of our competitive strengths of our assets and people. Free cash flow and production per share were 25-year records, operational momentum is strong and we are at an inflection point to sustainably return more profit and provide an outsized return to our shareholders. With that, I'll turn it back to the operator to open the line to questions.

[Operator]

[Operator Instructions] Your first question comes from Patrick O'Rourke from ATB.

[Patrick Joseph O'Rourke]

Sort of a 3-part question here on Attachie, so I'll fire them all out there because they are interconnected and then maybe you can answer them as you see fit. Just wondering here, in terms of the permitting issue and things that are going forward, obviously, the Blueberry and the BC government have the preliminary agreement in place, which allows for pre-existing permits to move forward here, excluding 20. Is sort of the delay here or stepping back and waiting for this to resolve itself, is this more about prudence? I know in the past, you said you had mostly all the permits in place for Attachie or you caught up in those 20 permits that were sort of excluded from the agreement. I guess the second thing would be, timing-wise, you guys have been very consistent in terms of your sanctioning of projects. They typically come out with the Q3 budgeting process. And we're wondering if this could be sort of a special case here this year, where if you do see a full resolution to this issue, could we see a change to the budget mid-cycle here and a sanctioning essentially effectively when the issue is resolved? And then the third and final question on it is in terms of cost and procurement, are there any risks on the cost drift or a cost drift on the $600 million here? I know you guys probably -- you've done all the engineering, you've done all the procurement, but are there any time-sensitive items in that procurement process there? And is there any seasonality involved with how you [ take it ] going on the construction for the project?

[Terry Michael Anderson, President, CEO & Director]

Perfect, Patrick. Well, it's Terry here. Thanks for the question on Attachie. So let's start with the permitting side. And it is about prudence. So if I give a little background, I've been spending a lot of time talking to First Nations, BC government, oil and gas commission. And everybody is trying to come up to the same agreement in that we want to progress activities and just about how do we do it in a responsible manner. So I have confidence where this is going, and that's why you see us -- the $75 million in long lead time items. But we want to have a 100% guarantee that we know the regulatory framework going forward. And so it is about just stepping back and waiting for -- to make sure that we can drill all the wells that we need to drill to continue producing into this facility. And you're right, we do have most of the permits for building the facilities and the pipelines. So for us, it's just being a little, I guess, taking a cautious approach to making sure that everything -- we know all the rules of the game before we step into the full $600 million. So that's -- but I have confidence where everything is going on the negotiations. And it's just a matter of time before this is going to be resolved here because everybody wants it to be resolved. So that's on the permitting side. On the timing side, yes, we could see a change in the budget, and we call this our preliminary 2022 budget with that in mind. If we get this approval by the end of the year, then we will look at changing our budget in the new year and get going on Attachie. We have everything in place from -- our plans that are in place, ordering of equipment is already happening. So we're set up to get going as quick as possible as soon as we get that ruling figured out from the BC government and the Blueberry. So midyear, whatever time in the year, as soon as we get that comfort, we will actually sanction in 2022. We don't have to wait for Q3, I guess, is the point. And maybe I'll turn it over to Armin more on the cost and the risk on inflation on the $600 million. But I think that what we're seeing from the efficiency gains that we are seeing in Kakwa, some of those relate back to Attachie, too. And so I think also ordering some of our equipment ahead of time is helping mitigate some of those inflationary pressures. But Armin, maybe you have more flavor on that side.

[Armin Jahangiri, Senior Vice President of Capital Projects]

Yes. Thanks, Terry. So in terms of the time-sensitive items that you talked about, Patrick, the $75 million is effectively just to address that specific question. It really allows us to have the long lead items ready for a project like that. And so that gives us flexibility in order to be able to advance when the time is right. Cost pressures, I guess, specifically to Attachie, I don't think there's anything unique about that project that differentiates it from the other projects that we are executing. We've seen inflation impact across the board on the price of steel, labor costs, all the other factors. We have estimated that to be about 5% to 7% impact on our overall capital expenditure. But as Terry said, our goal and expectation is to be able to actually offset all of that using efficiency of execution and the continuous improvement initiatives that we see across the board in the company. So Attachie will be just like any other project as far as we can tell.

[Operator]

Your next question comes from Travis Wood from National Bank Financial.

[Travis Wood, Analyst]

Yes. I want to stay on Attachie and maybe 2 parts to this question, if I can. First, what do you guys need from these negotiations? What are you expecting out of these negotiations to provide some more certainty and clarity? And then what does that critical path look like for you guys to start to commit incremental capital to Attachie? And then the last part would be, if we see delays into 2022, was there a cushion on the onstream date kind of the back end of '23? Like do you expect that, that on stream for 2023 changes, even though there are potentially some upfront delays on Attachie?

[Terry Michael Anderson, President, CEO & Director]

Thanks, Travis, for the questions. It's Terry here again. So as for clarity, we need to see clarity on the permitting authorizations. That's the biggest thing in the negotiations with the BC government and the Blueberry River First Nations is what's the mechanism for these permit authorizations, which take into account cumulative effects. And so that's the biggest thing that they are talking about. And there's other finer details, but that's the biggest concern. So we need to make sure we know what the rules are for us when we're permitting activities, what we have to do and make sure that makes sense for our business. So from that perspective, that's what we're looking for is that clarity. And that's what this is really all about is the clarity on the permitting authorization. So that is basically the critical path to everything that we are doing for Attachie. Everything else is ready to go. We were ready to sanction Attachie, well, right now, if it wasn't for the Blueberry and government negotiation issues that we're seeing right now. Otherwise, everything is ready to go on, ready to pull the trigger on this thing tomorrow. So -- but if it is delayed further into 2022, yes, that will impact the 2023 start time. We still need -- whenever we start, we need at least 18 months to complete the facilities and drill the wells to have everything on stream. So it's basically whenever we sanction, it's 18 months out from then is kind of how you'd look at that.

[Kristen J. Bibby, Senior VP & CFO]

And Travis, I would just add, it's Kris here. The way we would see this playing out is when we get that regulatory certainty, we'll circle back with Armin and his team and say, okay, what's your onstream date, what's the capital you can efficiently deploy in whatever time is left in that year and the following year, and then we'll update the market accordingly.

[Operator]

Your next question comes from Jeremy McCrea from Raymond James.

[Jeremy McCrea, Director & Equity Research Analyst]

Two questions here. One is can you give a little bit more detail with this LNG agreement that you guys signed here? Is there more to come after that? Was this just a little preview of what's possible here? Any other additional clarity on that? And then if you could also provide a little bit more context in terms of the breakdown between -- the distribution between buybacks versus potentially special dividend, variable dividends in terms of 50% to 80% payout to shareholders?

[Terry Michael Anderson, President, CEO & Director]

So Jeremy, Terry here. I'll take the first one and then throw the second one to Kris. So on the LNG deal, we can't give much more detail on it, but we can say that it's advantageous to North American-based pricing is what we are. So from that perspective, we're net positive on this. It's a strategic deal. It's about building long-term relationships. And to your point, then, yes, we do believe there's other opportunities out there. And I think for ARC, just with our Sunrise asset in particular, it is probably the greenest facility in North America and it's actually the proximity to the Coastal GasLink. And it's the reliability of ARC's operations that people are looking for to partner with. So when you -- and our investment grade where we have enough size to us in the resource. When you add all those up, we're a good partner for long-term LNG agreements like this. So I guess that's about all I can add to flavor to that. And then maybe, Kris, maybe you want to touch on second question.

[Kristen J. Bibby, Senior VP & CFO]

You bet. So in terms of buybacks versus dividends, obviously, I touched on it in the opening, but we do want to lean on our base dividend as the primary long-term mechanism, but it will be supplemented by the share buybacks just to make sure that we do get into that range of that 50% to 80%. I mean the market is giving us an opportunity or we view as an opportunity with the discounted valuation we see in the market currently. So we will be spending heavily on that and getting up to our full allotment of our 10% NCIB is what we would anticipate over the remaining 8 months that we have left on it. So it's going to be a portfolio approach where it's got a little bit of everything, and that's where we're going to start, and we'll keep moving forward with that as we see throughout the year.

[Operator]

Your next question comes from Aaron Bilkoski from TD Securities.

[Aaron Bilkoski, Analyst]

Just a follow up on Jeremy's question. If we have seen the regulatory sort of in BC settled and more capital is spent at Attachie in 2022 than what's in the preliminary budget, does this slow the pace of buybacks and future dividend increases? Or does the CapEx come out of the remaining 20% to 50% of the free cash flow that's allocated to the balance sheet?

[Kristen J. Bibby, Senior VP & CFO]

Yes. Good question, Aaron. It's Kris here, obviously. So when we were designing the framework for our capital allocation, we were certainly mindful of where we were in this process. So it's the latter approach that we know that we have the flexibility with that remaining 20% to 50% that will allow us to continue on the buybacks, continue on our dividend journey and execute the business and profitably invest in our underlying assets to grow the business and the free cash flow for the long term. So it's the latter of those 2, Aaron.

[Operator]

Your next question comes from Elias Foscolos from Industrial Alliance Capital Markets.

[Elias A. Foscolos, Equity Research Analyst]

I want to focus a bit on the new dividend and the sustainability. You kind of pegged the dividend to be -- or the new dividend to be comfortably funded at USD 40 WTI and I'll just call it $2 AECO. But I kind of see a third leg to that, which is the LPGs or butane and propane specifically. Are you pricing in what I see as a structural improvement in those prices relative to WTI/condensate? Just without getting too granular, I think it's important. So any color on that would be appreciated.

[Kristen J. Bibby, Senior VP & CFO]

Thanks, Elias. It's Kris here again, so I'll try to answer that one. We're not changing any material assumptions on it. I mean clearly propane has experienced quite a bit of strength right now. Butane is pricing very strong relative to WTI. But we're not forecasting any material change to those relationships. So really, it is about a stable relationship. You have seen us work hard over the last several years to make sure we do have some exposure to the spot consistency or spot market on the NGL streams. But we're not changing the assumption on the relationship of those values going forward. So we think it as long as it stays relatively steady, it is -- that's the relationship we're carrying on. I mean it is a relatively small component of our revenue overall, but it is an important component.

[Elias A. Foscolos, Equity Research Analyst]

Okay. Just maybe sort of another macro question with the potential for ethane cracking or another ethane cracker in Alberta, is there some capital projects that might be directed towards feeding a plant like that or not?

[Kristen J. Bibby, Senior VP & CFO]

I think at the end of the day, we'll evaluate -- there's some vague wording in there how we will evaluate all the opportunities ahead of us. And we do like to evaluate things before we commit to anything. So we will look and make sure like when we evaluate these things, it's about are we more profitable after the fact or before the fact and what is the risk that we're absorbing in it. So I don't have a crisp answer for you, we will or won't do it, but what I will assure you is we will evaluate. We've got a lot of NGL stream that we have available as well as natural gas that we can put into these types of projects. And fortunately, we have the scale where we do get approached to at least evaluate these opportunities, and we'll continue to do so.

[Operator]

Your next question comes from Michael Harvey from RBC Capital Markets.

[Michael Steve Harvey, Analyst]

Just had a question about the use of free cash. So you kind of mentioned that it's unlikely to be used for M&A. Just wondering if you could provide us some details on that. Is it just pure efficiencies that are driving that, so yours are better than others? Are the assets just not available that would be complementary? Is it pricing? Or is there -- are you just kind of [ fill up ] with 7G and your own stuff right now? Just any thoughts from the team and the Board on kind of how you guys are thinking about that. Obviously, some mixed views from your peers on that point.

[Terry Michael Anderson, President, CEO & Director]

Yes. Thanks, Michael. It's Terry here. So the answer is yes to all of those. But like I guess when we're looking at M&A opportunities, we're not looking for large, I guess, significant M&A opportunities. We've done the best one that we seen out there and now we are seeing the benefits of that. And you see the extensive free cash flow that we're delivering and the efficiency gains that we're seeing that we thought we could realize by operating the way ARC operates it. It does not mean that there aren't opportunities smaller in scale that are more bolt-on opportunities that we are looking at. That's always something that we do day in and day out within our teams. But we have such a big resource. And I think it's, in my opinion, some of the best resource out there. So that's why we are focused on optimizing our Kakwa, in particular, asset and it's a huge resource at 180,000 BOE a day of production. And so that's our first step, is making sure that's as efficient as it possibly can be. And then we never ever say we're not looking at opportunities, but the bid-ask spread with stronger commodity prices is more challenging right now. And so we don't see the sweet opportunities that were there 6 to 12 months ago. And so probably that's more of how we look at it and our view on it. So we are fine with continuing to optimize, taking that free cash flow and giving the majority of that back to our shareholders. And our stock price is undervalued significantly. And so I would rather invest in that. That gives us more return for the true value of our assets than it is going outside and looking at other opportunities.

[Kristen J. Bibby, Senior VP & CFO]

Okay. Operator, I'm not sure if there's any further questions on there.

[Operator]

[Operator Instructions] There are no further questions at this time. Please proceed.

[Kristen J. Bibby, Senior VP & CFO]

Well, I'd like to thank everyone for joining us this morning. Really appreciate it and appreciate the support as investors. And if you have any further follow-up questions, please don't hesitate to reach out to the team here, and we'll be happy to have a chat. Hope everyone has a great day.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.